Does financial integration impact performance of equity anomalies?

Abstract

We examine prominent market anomalies and evaluate the efficacy of alternative asset pricing models under different financial integration settings. A financial integration index is developed for classifying 25 sample markets into high-, medium- and low integration groups. Size is found to be the strongest anomaly in world markets, followed by value and liquidity. Value and profitability effects are larger for low-integrated markets. Highly integrated markets experience short-term momentum while many low-integrated markets exhibit mild reversals. Fama and French five-factor model outperforms capita l asset pricing model (CAPM) and Fama and French three-factor model in explaining returns. International factors augment the role of local factors for more integrated markets. Our study has implications for global investors to design anomaly based investment strategies.

Keywords:

• financial integration index
• asset pricing anomalies
• factor models

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Morgan Stanley classifies the countries into “Developed”, “Emerging” and “Frontier and Standalone” Markets.

2. In asset pricing domain, anomalies are seen as abnormalities which cannot be explained by multi-factor models as they violate the risk-return relationship. Prominent anomalies like firm size, value, momentum have a rich literature, but studies on profitability, investment and liquidity are thin, especially for emerging markets. Section two discusses literature review about market anomalies.

3. Investment effect or the asset growth effect means higher returns are generated by firms which are conservative in investing.

4. These 47 markets are USA, UK, Netherlands, France, Germany, Canada, Sweden, Australia, Switzerland, Denmark, Mexico, Norway, Belgium, Spain, Austria, Italy, Singapore, Hong Kong, Brazil, South Korea, South Africa, Finland, Hungary, Taiwan, Portugal, Japan, Czech Republic, Russia, Chile, New Zealand, Indonesia, India, Greece, Thailand, Peru, China, Pakistan, Malaysia, Poland, Argentina, Turkey, Sri Lanka, Israel, Philippines, Colombia, Egypt, Jordan.

5. See IMF Paper titled Recovery from the Asian Crisis and the Role of the IMF by IMF Staff, June 2000 https://www.imf.org/external/np/exr/ib/2000/062300.htm#I

6. Table 2 illustrates that HIG countries: United States, UK, France, Germany, Canada, Sweden, Australia, Spain; MIG countries: Italy, Singapore, Hong Kong, Brazil, South Korea, South Africa, Taiwan, Japan, Indonesia; LIG countries: India, Thailand, China, Pakistan, Malaysia, Turkey, Israel, Egypt.

7. Due to space constraints, Tables 3–8 contain results only for the decile corner portfolios. Results from second to ninth decile portfolios can be made available on request.

8. Robustness test results are not included in the paper owing to paucity of space and can be made available upon request.